RBA rate cut expectations rise

Bianca Hartge-Hazelman

Most economists think the Reserve Bank of Australia should keep rates unchanged when board officials meet on Tuesday, despite financial markets pricing in an increased chance of a cut just as the Australian dollar trades closes in on a six-year low.

Respected Bank of America Merrill Lynch chief economist Saul Eslake is among a group of economists who believe the RBA should resist market pressure to cut rates beyond the 2.5 per cent setting but he admits that it will be a close call.

"Based on how we are reading the economy we can't see a strong case for cutting rates right now or in the foreseeable future. We see rates steady this year with an increase in 2016," he said. "If they do move as a form of insurance they will probably need to take it back sooner," he said.

A smaller, yet growing number of economists think the RBA should cut rates, and if it doesn't act it will pave the way for a cut in its post-meeting minutes on Tuesday and its Statement on Monetary Policy to be released on Friday.

"It's a close call as to whether the Reserve will actually cut on Tuesday or wait till March as it may prefer to prepare the way for a cut by dropping the reference in its post meeting statement to a "period of stability in interest rates" being prudent and by lowering its inflation forecasts," said AMP Capital chief economist Shane Oliver, who expects a rate cut.

"We are expecting the RBA to cut its underlying inflation forecast on Friday to 2.25 per cent," added Westpac Banking Group's chief currency strategist Robert Rennie. "Fourth quarter consumer price inflation (CPI) data might have been stronger on a core basis but given the ongoing weakness in oil prices, you would be expecting further weakness."

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The Australian dollar fell to US77.61¢ on Thursday night, its lowest point since May 2009 as the interest rate swaps market started pricing in a 65 per cent chance of a rate cut, up from the 50 per cent odds earlier in the week. The Aussie dollar was last trading slightly higher at US77.66¢.

Markets are speculating that the RBA will surprise investors on Tuesday and follow in the footsteps of central banks in Canada, Singapore, Denmark and Russia by unexpectedly loosening monetary policy.

The Australian dollar's 16 per cent plunge against the US dollar, coupled with falling global oil prices over the past six months, has started to raise doubts about the strength of the upcoming Australian profit season.

While some exporters will likely feel the pain from a lower Aussie, companies which report sales in US dollars are expected to benefit from the currency's steep decline.

Advocates of a rate cut say such a move is necessary to keep downward pressure on the local currency and to revive economic activity even at the risk of stoking the heated property market and spurring lending to both domestic and foreign investors.

"Since the disappointing third quarter GDP figures, we have been forecasting a rate cut in February, " said Mr Rennie. "I think there is a compelling argument for the RBA to execute that.

He added that the RBA is likely to follow other global central banks by cutting rates because of continued weakness in Australia's terms of trade due to falling commodity prices and soft global growth outside of the United States.

"I have been involved in financial markets for close to 30 years and I cannot remember a month where so many central banks have reacted so aggressively in such a short period of time. I think they are reacting to the set of financial conditions that they face, and the currency is only part of the story."

Over the past year, the spot price for iron ore has halved from over $US120 a tonne to over a five year low of $US62.21 for benchmark iron ore for immediate delivery to the port of Tianjin in China.

UBS chief economists Scott Haslem changed his view on rates from hold to 50 basis points of cuts in March and May following last week's CPI data. Australia's annual headline CPI rose 1.7 per cent in 2014, only slightly below the 1.8 per cent rate that economists had expected.

Westpac Banking Group and Macquarie are also among the most aggressive in their views of two rate cuts in the first quarter of this year.

While the Australian economy is soft it is not completely deteriorating, the main areas of strength in non-mining sectors are coming from construction, recreation, transport and financial services – all of these relatively labour-intensive sectors which should help to support employment.

The NAB's December business survey showed "a patchwork economy with little to no momentum building" following on from November's equally soft result.

Business confidence remains well below long-run averages. Mr Eslake blames dissatisfaction with national politics for this.

"It is unusual for confidence to be going down at this time and I think it is because of politics. People are either increasingly frustrated at the performance of the government or increasingly frustrated at the inability of the government to govern because of Labor and the minor parties," he said.

"On top of that the RBA has consistently said that if the economy does need more stimulus they would prefer it come through a lower exchange rate," he said adding that because the market is pricing in a rate cut at this Tuesday's meeting, if it does not happen the Australian dollar should appreciate.